A September rate cut may signal something's off: Strategist

It’s beginning to look more and more like the Federal Reserve could hold interest rates higher for even longer, at least according to several Wall Street experts. MUFG Head of US Macro Strategy George Goncalves examines several market pressures (^DJI, ^IXIC, ^GSPC) stemming from the potential for Fed rate cuts that may not come until late 2024.

"It gives them a down payment towards their easing which we know they want to do. They have it in their forecast, they know it's restrictive," Goncalves says. "They don't want to create any sore of... undue harm to the economy down the road. But if you miss the June/July window, the only reason then you would cut in September is if something progressively gets worse. That's kind of the irony here."

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This post was written by Luke Carberry Mogan.

Video Transcript

- Stocks higher, heading into the close after Federal Reserve Chair Jerome Powell said it will take longer than expected to get inflation down to the central bank's 2% target, meaning it's likely going to take longer to cut rates. Joining us now is George Goncalves, MUFG head of US macro strategy.

George, it's great to see you. It's been a while since we have chatted. And I'm curious what you made of Powell's comments today, if it's sort of he's confirming what we already know, or do you think that is indeed notable that he did sort of confirm this view that the market already seems to have come to?

GEORGE GONCALVES: Look, well, the market's been kind of dragged here, too. And obviously, great to see you, as well, and good to be on. This has been a market that's been fighting the Fed for so long that it's in this process of giving up. And in many ways, in doing so, it's doing the tightening for the Fed.

We had a pretty big rise in longterm rates. It's longterm rates that matter more at this point. The Fed's not going to hike, most likely not going to hike. And so at this point, it's more about, can rates normalize? And by doing so, that's like introducing tightening.

So I mean, look, I don't think we've learned terribly a lot from today's conversation with Chair Powell, but it does confirm that they need confidence, and they really are lacking right there.

- George, I'm interested to get your take on just when you think about the trajectory of inflation over this year, George, what does it look like to you?

GEORGE GONCALVES: I mean, look, we are in the camp that it is a bumpy move towards lower inflation. Nothing's ever linear in life, and that's including the markets, as well as an inflation process. I mean, it's complicated right?

You have demand forces. You have supply forces. Sometimes going in the same direction or in opposite directions. And we are at that risk of supply constraints adding to inflation. And this really creates a big challenge for the Fed and for market participants all around that, should we look through this temporary inflation? Because you can't use the word transitory because you know what that means.

And so it's a real big challenge to understand where we are in the cycle. I think it's heading lower. It's not going to be a straight line, and that's-- it's going to really frustrate both policymakers and markets alike.

- Well, we've had a number of people say to us, the Fed wants to get on with it, right? They want to be able to cut here. The calendar, though, could prove a little challenging for the Fed, right? Because you have the June and July meetings. Then you've got a September meeting, which is going to be in the thick of presidential and congressional campaign season.

And then you've got a meeting right after the election. So is it-- if they don't cut in June and July, would it even be possible to make a move at that September meeting?

GEORGE GONCALVES: That's a great point. And that's really why my view has been more nuanced, which is, does 25 basis points really matter? I mean, let's be honest. 25 bips is not going to change things that much. And it gives them a down payment towards their easing, which they want to do. I mean, they have it in their forecasts.

They know they're restrictive, and they don't want to create any sort of undue harm to the economy down the road. But if you miss the June, July window, and the only reason then you would cut in September is if something progressively gets worse.

So that's kind of the irony here. It's almost better to go early and then skip a meeting, like September, and then wait for the election, and then go again if need be. But if you wait until September, the only reason why they'll cut in September is because something's gone wrong with the data or in the market somewhere.

- And switching gears, George, a bit. Another topic, front and center, for investors right now is geopolitical risk. We don't know what the Israeli response to the Iranian strike over the weekend will be, George. But just as a strategist, walk me through how you're thinking about geopolitical risk right now.

GEORGE GONCALVES: Look, it's the tail risk that you have to be mindful of, and you need to incorporate that into your thought process, as well as like what sizing of trades and ideas makes sense in this sort of environment. So it is playing a crucial role.

And I'm sure it's one of the reasons why there's some trepidation amongst traders and investors to not really be fully allocated with whatever view you may have because you just don't know. It can go in either direction. And even if you think you know the outcome, the market might respond completely in a different direction.

So I think the geopolitical thing is an important aspect for, really, the three channels that I focus on the most, which is longterm interest rates, which could be linked to oil, what's going on with oil by itself, and then the dollar. I mean, those three things will dictate how, I think, markets will perform over the next two to three months. And again, we don't have any clarity or certainty what's coming out of the Middle East for sure.

- George, I'm also curious what you make of a view that is gaining a little bit of traction that was once sort of anathema on Wall Street, more common in places like Turkey, oddly, that by keeping rates, by keeping policy quote-unquote, "tight," that the Fed has actually kept the economy hot because people have so much income right now because of those high rates, keeping money in things like money market funds, that they've had more money to spend. What do you make of that view?

GEORGE GONCALVES: So that, to me, is more of a narrative to justify what's happening than an actual reality in the sense that-- and this is the big problem which we've always had all throughout. It's a bifurcated economy. Sure, those that have large cash balances, either institutional or high net worth, yeah, they're probably building up cash balances.

Now, the question is, are they consuming that cash balances or just sitting on it, number one? Meanwhile, on the other side of the spectrum, you have 80% of the population who are actually feeling the brunt of higher rates. And so it's a very bifurcated economy that the rates channel is disproportionately impacting lower income versus upper income.

So yes, is it working? Is it enough to keep the economy going? I don't think so.

- George, thanks for joining the show today. Appreciate your time.

GEORGE GONCALVES: My pleasure.